In his speech before the Independent Community of Bankers of America on March 17, 2004, the Chairman of the Federal Reserve Board, Alan Greenspan, concluded that the US banking system is in healthy shape. According to the Fed Chairman, the weakness in credit quality that accompanied the recent recession has clearly been mild for the banking system as a whole, and the system remains strong and well positioned to meet customer needs for credit and other financial services.
Basically, there's good credit and false credit, and they compete against each other.
There are two kinds of credit: that which would be offered in a market economy with sound money and banking (good credit) and that which is made possible only through a system of central banking, artificially low interest rates, fractional reserves, deposit insurance, and bailout guarantees (false credit).
Does that not sound accurate? How long can these absurdly low interest rates being offered by our de facto national bank be sustained?
Despite the apparent complexity that the banking system introduces, the act of extending credit remains the transfer of saved real stuff from lender to borrower. Without the increase in the pool of real savings, banks cannot create more real credit. At the heart of the expansion of good credit by the banking system is an expansion of real savings.
The national savings rate is extremely low. How much longer can the US power the world economy? You can only consolidate your credit card debts by taking out your savings in your house with your home equity line of credit so many times before your equity (which may have been accumulated over 20 or more years) disappears.
We can thus conclude that as long as the increase in lending is fully backed up by real savings it must be regarded as good news since it promotes the formation of real wealth. Only false credit, which is generated out of "thin air", is bad news. Low interest rate policies by the Fed both encourage the expansion of false credit and discourage saving, in a process that brings about continually weakening financial conditions.
Curiously some commentators are of the view that any type of credit helps grow the economy. This way of thinking is based on a crude empiricism, which supposedly shows that the expansion in bank lending and the expansion in economic growth are closely correlated. However, only credit which is backed up by real savings is an agent of economic growth. Credit which is unbacked by real savings is an agent of economic stagnation.
The banking sector is very vulnerable
To be sure, the existence of fractional reserve banking and all the other institutions that assist in the creation of false credit have been in place for a very long time, generating ongoing bouts of boom and busts and distorting the economic system. What makes the prospect more serious this time is the low savings rate, the rock-bottom interest rates, the sad condition of household balance sheets, and the vulnerability of banks themselves.
The rapidly diminishing ability of the US to generate internal real funding is seen in collapsing consumer savings and ever expanding government. For instance, the consumer savings rate stood in January at 1.8% against 10.4% in April 1980. The personal income-to-personal outlays ratio is currently in free fall. The pace of individuals' spending is much faster than the pace of income generation.
The consumer savings rate (think about how much your hear on the news that it is the consumers who drive the economy) has tanked. This should be self explanatory. It's BAD! What happens when the easy credit disappears and people stop buying $40,000 SUVs and BMWs?
In sum, the pace of credit expansion by far outstrips the pace of income generation. This is another indication that the pool of real savings is in trouble. If it would have been otherwise then income would have grown much faster and would have easily absorbed any increase in debt.
Part of the reason behind this is entites like MTV. You're just not cool if you don't drive a Ford Expedition or BMW (both new, of course), wear $100 shirts, have nice jewelry, even if you're a guy, etc. Our terminally "hip" culture and desire to be "cool" isn't cheap. Old virtues like thrift, patience, and industriousness aren't exactly in vogue today. We gotta have it now.
Another important drain on real resource remains the ever-growing size of the government. Contrary to most analysts, it is not the budget deficit as such but rather government spending that weakens the pool of real savings. It is growing government spending that does the damage by diverting real resources from wealth producers.
You can't always count on a feverishly hot economy to bail you out, like Clinton was fortunate to have (also thanks to not vetoing Republican tax cuts). Bush has done EXTREMELY POORLY in this regard.
Against the background of deteriorating savings conditions and rising debt, how is the US economy managing to show a reasonable performance? The answer to this can be found in the balance of payments. For 2003, the US current account deficit closed at $541.8 billion—up from $480.9 billion in 2002. In early 2004 the trade gap has continued to widen further. It stood at $43.7 billion in January against $42.7 billion in the previous month.
The continued widening in the trade gap is the manifestation of a positive net stream of real resources coming from the rest of the world to the US. The fact that the US can print dollars that are eagerly accepted by foreigners enables it to divert resources from the rest of the world. To put it briefly, by means of printing presses the US keeps its economy going at the expense of the rest of the world.
For the time being, not only are foreigners happily channelling their real resources into the US but they are also doing this in return for the liabilities of a non-wealth generating entity called the US government. Foreigners are exchanging real stuff for unbacked promises. For instance, at present, foreign central bank holdings of T-Bonds exceed $1.1 trillion, or 10% of US GDP. So at the moment, the US remains at the mercy, so to speak, of the rest of the World.
We can thus conclude that the banking system is far from being in healthy shape as suggested by Greenspan, but on the contrary it is very vulnerable to a sudden weakening in economic activity.
Also, contrary to Greenspan's view, the banking system is not well positioned to expand credit since there is very little savings left. Any further bank credit expansion means an expansion of credit out of thin air. Obviously, this type of credit expansion will only further undermine the health of the economy and ultimately the bank's own health.
In fact, since a large chunk of credit was created out of "thin air" there is high likelihood that it will evaporate back into "thin air." It seems to us that against the background of rapidly deteriorating real fundamentals the Fed will be forced in the not too distant future to reverse its stance, thus setting in motion the inevitable liquidation of various artificial forms of life that currently comprise bank balance sheets.
Startvalve From , joined Dec 1969, posts, RR:
Reply 3, posted (11 years 1 month 3 weeks 4 days 21 hours ago) and read 1247 times:
Typically the problems do blow over. Ask any economist, the business cycle is just that, a cycle, it goes up it goes down, that effects all facets of the economy, banks included.
Look at how many Americans, especially ones in their 20s actually save money. Most people I know have very little in savings, they talk big about starting a savings account but unless retirement is on the near horizon its not something on their mind. So with nobody saving that sort of hurts the assets of a bank. So yeah it is possible they are in trouble. Greenspan is good at what he does, trust the man... Yeah we all have mistakes but he typically doesn't throw out a warning unless there is something to it. Also remember, the Fed is bigger than 1 man, what he is speaking of didn't fully come from his noggin, it is almost certainly a consensus opinion of many people far smarter than any of us.
Klaus From Germany, joined Jul 2001, 21592 posts, RR: 53
Reply 4, posted (11 years 1 month 3 weeks 4 days 20 hours ago) and read 1244 times:
The problem is if the "It´ll blow over!" attitude becomes too ingrained to recognize when the fundamentals start slipping in earnest... Or when his political preferences (Greenspan´s known to strongly favour the republicans) get the better of him in an election year...
B2707SST From United States of America, joined Apr 2003, 1375 posts, RR: 59
Reply 6, posted (11 years 1 month 3 weeks 4 days 18 hours ago) and read 1234 times:
I'd agree with most of Frank Shostak's article - the decline in the US savings rate is alarming and has ominous consequences for economic growth in the long term. For now, we're able to keep consuming because of foreign investment, but it's anyone's guess how long foreign banks will keep investing here despite our absurdly low interst rates.
Greenspan has been given too much credit, IMHO. He was widely criticized for not acting quickly enough during the 1990-91 recession. He and the Federal Reserve Board were aware of a stock market bubble as early as 1996, but did nothing to help stop the problem. In fact, Greenspan cut interest rates in 1996, despite the fact that the economy was already at full employment, and injected huge amounts of new money into the economy during the latter half of the decade. While the intention was to forestall potential crises like the Mexican peso devaluation, the Russian debt default, the Long-Term Capital Management implosion, Y2K, etc., that newly created money went straight to the capital markets and fueled the stock market bubble. Once Greenspan realized that inflation was on the rise (18% annualized growth in the money stock tends to do that), he raised rates too quickly and popped the bubble with a vengeance.
The Mises Institute is affiliated with the Austrian School of economics. They're usually regarded as something like pariahs by the mainstream, mostly due to methodological differences and because Austrians are hard-core libertarians, but they were about the only school that foresaw the tech boom and the impending crash. The Austrian journals in the late 1990s were full of warnings about the unsustainable boom (one example). I think one has to give them credit for that, at least. The Austrian business cycle model fits the boom/bust we've just experienced to a T.
Ask any economist, the business cycle is just that, a cycle, it goes up it goes down, that effects all facets of the economy, banks included.
Actually, many schools do believe the business cycle is caused by government intervention. Monetarists, New Classicists, Austrians, and even New Keynesians (to some degree) would blame the government for creating cycles and/or allowing them to persist.
Even libertarians are complaining about the preponderance of liberals in higher indoctrination. This incident concerns establishing the premier economics school of the Austrian thought in the US at UNLV, but no thanks, says the liberal faculty.
Plus, no university will allow more than one or two free-market economists to teach in a department. UNLV is no exception. When the renowned Murray Rothbard and Professor Hoppe were both at UNLV, they attempted to recruit fellow free-marketer Walter Block to the UNLV economics department – forming what would have been the premier Austrian school economics department in America. Block’s addition would have insured that the department attracted economics students from all over the globe. But the leftist department chair at that time nixed Block’s potential hiring immediately.